Research Discussion Papers, Bank of Finland
No 16/2015:
Firms’ risk endogenous to strategic management choices
Mantos D. Delis ()
, Iftekhar Hasan ()
and Efthymios G Tsionas ()
Abstract: Use of variability of profits and other accounting-based
ratios in order to estimate a firm's risk of insolvency is a
well-established concept in management and economics. This paper argues
that these measures fail to approximate the true level of risk accurately
because managers consider other strategic choices and goals when making
risky decisions. Instead, we propose an econometric model that incorporates
current and past strategic choices to estimate risk from the profit
function. Specifically, we extend the well-established multiplicative error
model to allow for the endogeneity of the uncertainty component. We
demonstrate the power of the model using a large sample of U.S. banks, and
show that our estimates predict the accelerated bank risk that led to the
subprime crisis in 2007. Our measure of risk also predicts the probability
of bank default both in the period of the default, but also well in advance
of this default and before conventional measures of bank risk.
Keywords: risk; strategic management; endogenous; profit function; (follow links to similar papers)
JEL-Codes: C13; C33; E47; G21; G32; (follow links to similar papers)
45 pages, August 20, 2015
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Delis, Mantos D., Iftekhar Hasan and Efthymios G Tsionas, 'Firms’ risk endogenous to strategic management choices', British Journal of Management.
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